Understanding the different stock types is important when choosing which to include in your portfolio
- The main stock types are common and preferred, each of which has benefits and drawbacks.
- Common stocks typically come with voting rights, while preferred stocks guarantee dividends.
- Stocks are also further classified by characteristics like industry, market value, growth potential, and volatility.
When researching stocks, you'll often run into descriptions like "common" and "preferred," as well as "Class A" and "Class B." The type you decide to invest in will depend on your financial goals. While every stock represents a portion of ownership in a company, there are key distinctions to be aware of before choosing which kind to add to your portfolio.
What are the two main kinds of stocks?
Stocks are divided into two broad categories: common and preferred.
Most people own common stock, which gives shareholders ownership in the company as well as voting rights, in most cases. Holders of common shares also will receive dividends if the company provides them, although they aren't guaranteed and the amount can fluctuate.
Preferred stock is more of a way to collect income through dividends. "A preferred stock is kind of like a hybrid between a bond, which is a form of debt, and equity, which is a form of ownership," says Zach Weiss, research analyst for FBB Capital Partners. Typically, shareholders of preferred stock will receive guaranteed fixed dividends.
Additionally, if a company goes bankrupt or liquidates its assets, preferred shareholders get paid out before holders of common shares. Thus, preferred stock tends to be less volatile than common stock.
For some preferred stocks, the company can force shareholders to sell them back if the dividends become too high relative to the market. Companies set the redemption price, or call price, in the prospectus, and shareholders must sell for that amount.
Note: Preferred stocks can be useful if you're closing in on retirement since their fixed dividends can provide a steady source of income for investors. These stocks have less risk but also less reward, which makes them better for those close to retirement age.
Pros and cons of common and preferred stock
Common and preferred stocks both have benefits and drawbacks, and which one you choose depends on your investment strategy. Here are some of the main pros and cons of each:
| Common | Preferred | |
| Pros | There's more potential for long-term growth in share prices.They give shareholders voting rights.They typically aren't subject to redemption. | They usually provide guaranteed fixed dividends.Share prices are usually more stable. Holders get paid before common stockholders during liquidation. |
| Cons | Share prices tend to be more volatile.Investors get paid last during liquidation.They typically pay lower dividends (if any). | Shareholders have no voting rights.Most are redeemable at fixed prices.Share prices usually provide lower returns. |
Class A shares vs. Class B shares
Stocks can be broken down further into classes, typically Class A and Class B. Both have the same right to a company's profits. The main difference is in voting rights.
Voting rights can be structured in many different ways. In some companies, one class (typically Class A) carries more voting rights than the other. In other instances, one class holds all the voting rights for the company. In these cases, the company founders may own all the shares with voting rights, guaranteeing their power.
The non-voting class shareholders "are there to go along for the ride and whatever the Class A shares decide," says Sam Brownell, managing director of Stratus Wealth Advisors in Kensington, Maryland. "They have to be OK with taking the risk that they don't have any control over the direction."
Other companies designate certain votes for Class A only, like filling the board of directors or changing the strategic direction of the company. All classes might vote on other major decisions, such as dissolving the company or considering a merger.
Meta Platforms (formerly known as Facebook), is one example of a company using share classes to consolidate voting power. Meta has Class A and Class B shares, but Class B shareholders hold more voting rights — at a ratio of ten to one per share. Founder Mark Zuckerberg and a few insiders maintain control of the company through their Class B shares, while Class A is used mostly for raising capital. Zuckerberg owns almost 90% of Meta's Class B shares.
Brownell says it was clear that Zuckerburg wanted a lot of control from the beginning, but there are drawbacks to this setup. "Facebook has shown that there can be some issues with leadership and transparency when you as the founding member are essentially beholden to no one but yourself when making decisions."
Quick tip: To find out which classes of stock a company offers, head to an investment site like Morningstar.com and type in the company name. All of its offerings should appear in the dropdown.
Other ways stocks are described
Stocks are analyzed and discussed in many other ways beyond the main approaches used to parse out company shares.
Some of the most common include:
- Small-cap vs. large-cap. Based on the total market value of a company's shares. Typically, small-caps are generally considered those with shares worth less than $2 billion and large-caps are those worth more than $10 billion.
- Growth vs. value. Growth stocks have risen in value over time, while value stocks are from struggling or underperforming companies that are priced lower than their apparent worth.
- Defensive vs. cyclical. Defensive stocks typically hold up in an economic downturn because they are in industries with continued demand, like health-care and utility services. Cyclical stocks tend to fluctuate with the economy because of changes in consumer spending.
- Dividend vs. non-dividend. Dividend stocks provide payments to shareholders when the company has extra cash, while non-dividend stocks do not. Non-dividend stocks can have a higher share price and offer a better return for investors, but they carry more risk.
- Industry or sector. The Global Industry Classification Standard groups stocks from companies in similar industries together and defines 11 main market sectors to make comparisons easier. Energy, utilities, healthcare, and real estate are several examples of stock market sectors.
Note: There are generally restrictions on who can buy or sell the class of stock with the majority of voting rights. According to Brownell, families or founders do this to protect their company culture and vision from being too influenced by external forces.
The financial takeaway
Before forming an investment strategy, you need to assess your risk tolerance and your goals. If you're near retirement and hoping to gain an income, dividends from preferred stocks can give you a reliable source of cash but not a lot of growth potential. On the other hand, if you have a lot of years left to invest in the market, common stocks can bring higher returns.
As far as which companies to invest in, Weiss also recommends investing with management teams who own a portion of the company. "Maybe the founder of the company is still running it," Weiss says. "Generally, when the insiders have a lot of skin in the game, as a shareholder, you know that if I get burned, you get burned."
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